THE MARKETS: Market Place; Investors Settle For $2.8 Billion In a Fraud Suit

By JOSEPH B. TREASTER

Published: December 8, 1999

Cendant, the big franchiser that operates Ramada Inn hotels and Avis car rental agencies, agreed yesterday to pay its stockholders $2.8 billion to settle accusations of widespread accounting fraud. The settlement is by far the largest ever in a securities class-action suit.

The shareholders, led by the pension funds of New York State, New York City and California, contended that CUC International, an online and telephone shopping services company that combined with HFS Inc. in 1997 to form the Cendant Corporation, had greatly inflated earnings and profits and that executives no longer with the company sold shares before the irregularities were publicly disclosed. That disclosure wiped out billions in the company's market value.

''This is a company that engaged in egregious and fradulent practices,'' said H. Carl McCall, the New York State comptroller.

Investigations by the United States attorney's office in Newark and the Securities and Exchange Commission are continuing.

Shares of Cendant plunged to $19 from $35 on April 16, 1998, a day after the company announced widespread accounting irregularities at CUC, reducing the company's value by $14.4 billion.

Mr. McCall said that the New York State Common Retirement Fund, the New York City Pension Funds and the California Public Employees' Retirement System had lost a combined $89 million on that day.

Mr. McCall said the pension funds, which held 11.7 million shares when the irregularities were disclosed, expected to recover 40 to 60 percent of their losses.

Cendant, based in Parsippany, N.J., did not detail the accounting irregularities in April, but it reported in August 1998 that more than $640 million in profits reported for the previous three years had been fictional. The inflated profits, New York State officials said, helped to drive up the share price of CUC.

That would make the company more attractive to potential merger partners. And CUC executives, along with other shareholders, would have benefited individually as the stock price rose.

A little more than two weeks before the August announcement, the former chairman and chief executive of CUC, Walter Forbes, and eight former CUC directors resigned from the board. Mr. Forbes has denied any knowledge of the accounting irregularities. Four other senior CUC executives also resigned in the wake of the scandal.

In addition to the $2.8 billion settlement, Cendant also agreed, at the insistence of the pension funds, to several changes in its corporate structure to create a more independent board and to prevent executives from increasing stock option benefits without the consent of shareholders.

''This was a unique class action waged by large plaintifs and not your typical class action by owners of 100 shares or so,'' said John Coffee, a law professor at Columbia who specializes in corporate governance.

''These large pension funds,'' he said, ''were properly trying in this action to not only recover financial losses but to realize their priorities in corporate governance.''

Henry R. Silverman, the chief executive of Cendant, said the settlement ''brings closure to this most unfortunate event.''

Lawyers who negotiated the settlement said they could not discuss how much of the $2.8 billion they would receive because Federal District Judge William H. Walls had placed the terms of their payment under seal until all litigation is complete. But James W. Newman, an expert on class-action suits and the publisher of Securities Class Action Alert, said it was likely they would receive about 15 percent.

The rest is to be distributed to shareholders in proportion to their loses, said Leonard Barrack, a partner in the Philadelphia law firm of Barrack, Rodos & Bacine, which worked out the settlement with Cendant along with its co-counsel, Bernstein, Litowitz, Berger & Grossmann in New York. The amount for each of the roughly 300,000 shareholders has not been determined.

Shareholders and Cendant are separately suing Ernst & Young, the company's former accountant. The suits contend that the auditor certified CUC's false financial statements. In its suit, Cendant accused Ernst & Young of malpractice and breach of contract. As part of the settlement, Cendant said it would pass on half of any monetary awards in its case against the auditor to its shareholders.

Larry Parnell, a spokesman for Ernst & Young, said, ''Our contention is that we suffered fraud in that both CUC management and subsequently Cendant management provided to the firm financial information they knew was false.'' He said Ernst & Young had contersued Cendant and that it had been discussing a possible settlement with the shareholders.

The $2.8 billion is nearly double the previous record, the $1.5 billion that Prudential Securities paid in 1994 to settle claims by investors, many of them elderly, who lost money on high-risk limited partnerships they could ill afford. Previous settlements had been in the hundreds of millions, not billions.

''The settlements are starting to be much larger,'' Mr. Newman said. ''because of the overheated stock market. The prices of shares are so inflated that when bad news comes out billions of dollars are lost and investors are finally getting a decent recoupment of their losses.''

Mr. McCall and Alan G. Hevesi, the New York City comptroller, said the state and city pension funds had no plans to sell their stock in Cendant. ''The culture or philosophy of our pension fund management is to invest for the long run, not for a quick hit,'' Mr. McCall said. ''If we can have an influence on the company for the long run, that's good.''

''If we pulled out now,'' he added, ''we would suffer some losses because the stock is worth less than when we bought it.''

Aides to Mr. McCall said they could not immediately determine the average cost of shares to the pension funds but that they calculated their losses from the mid-30's price when the stock plunged. Cendant closed at $18.375 yesterday, up $1.1875 on news of the settlement.

''Cendant can again be valued based on the performance of our businesses without the overhang of this litigation,'' Mr. Silverman said. He said continuing federal investigations ''will not affect the company or its current officers and directors.''

The pension funds leading the suit reached an agreement with Cendant that the majority of its board would be independent, that the audit, nominating and compensation committees would be made up of independent board members and that all directors would be elected annually.

Elliot Bloom, a spokesman for Cendant, said that several changes had already been made. He said Cendant planned to ask shareholders to approve one-year terms for board members at its annual meeting.

The measure on stock options was designed to prevent a practice known as repricing, in which the exercise price of options is lowered when a company's market value drops. ''Many times management is responsible for a drop in the stock price, and they shouldn't be compensated for that,'' Mr. Newman said.

Mr. Bloom said Cendant had put the option requirement into effect immediately by executive order.